Inflation remains a hot topic, directly impacting everything from your grocery bill to interest rates. As of the latest data, two key inflation gauges — the Personal Consumption Expenditures (PCE) Price Index and the Consumer Price Index (CPI) — show that prices are still above the Federal Reserve's 2% target, with the core PCE at 3.4% and core CPI at 2.9%.
Key Takeaways
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Core PCE inflation reached 3.4% and core CPI inflation reached 2.9% in May.
- Inflation (from both measures) has moved away from the Fed's 2% target over the last several months.
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Core CPI has increased 1,004% since 1960, while core PCE is up 722% over the same period.
The Fed's Preferred Inflation Gauge
The Fed is on record as using PCE data as its primary inflation gauge, with a 2% target rate. Elsewhere, the Fed has stressed the importance of "core" inflation, which excludes food and energy prices which tend to be more volatile.
Finally, policymakers examine a variety of "core" inflation measures to help identify inflation trends. The most common type of core inflation measures excludes items that tend to go up and down in price dramatically or often, like food and energy items. For those items, a large price change in one period does not necessarily tend to be followed by another large change in the same direction in the following period. Although food and energy make up an important part of the budget for most households — and policymakers ultimately seek to stabilize overall consumer prices — core inflation measures that leave out items with volatile prices can be useful in assessing inflation trends. [Source]
The Federal Reserve concluded its fourth meeting of the year by maintaining the federal funds rate at 3.50%–3.75%. The decision, which markets had fully priced in, keeps the benchmark rate at its lowest level since November 2022 for the fourth meeting in a row. However, the recent data suggest the "last mile" of the inflation fight is proving difficult.
In their significantly shorter statement from the meeting, the Committee noted that, "Inflation remains elevated relative to the Committee's 2 percent goal, in part reflecting supply shocks that have driven price increases in certain sectors, including energy." However, they closed out by stating they "will deliver price stability".
The Fed will meet again next month where they are expected to hold rates steady. At the time of writing, the CMEFedWatch Tool shows a 70% likelihood the Fed will hold rates where they are versus a 30% likelihood of a 25 basis point hike.
PCE and CPI: A Side-by-Side Inflation Comparison
So, why does the Federal Reserve pay more attention to core PCE than core CPI when assessing its progress in managing inflation? A side-by-side comparison reveals key differences.
One of the primary reasons is volatility. Core PCE tends to be considerably less volatile than core CPI. This stability makes it a more reliable indicator for the Fed, which has a dual mandate of achieving price stability and maximum employment. Historically, the less erratic nature of core PCE has made it the preferred metric of choice, though the disinflationary trend in core PCE prior to 2022 casts doubt on the effectiveness of the Fed's monetary policy.
